CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Please ensure you fully understand the risks involved. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Please ensure you fully understand the risks involved.

Trader thoughts - the long and short of it

Compared to the epic tumble in US equities Monday - that properly spilled over to global risk assets Tuesday – this past session’s retreat looks rather tame.

Source: Bloomberg

However, it is far from a modest concern. With the concerted corrections that we have seen take hold over the past few weeks, investors will be exceptionally wary of their tendencies towards complacency. In the preceding year, the extremely low level of expected and realized volatility (unprecedented on many gauges) supported the resilient and almost mechanical advance in equities and other risk assets through the period. Yet, if the dip buying mentality fails to hold back the storm surge, the buy-and-hold lot more predisposed to traditional fundamental values (broadly over-stretched) will be motivated to reduce risk. That is the dry way of saying a more permanent bear trend could take hold.

Wall Street: We won’t likely beat Monday’s dramatic loss for US indices anytime soon – unless of course there is a liquidity crisis – but further significant declines will start to add up to a more disruptive bear trend. The S&P 500’s slide Thursday was the second steepest loss (beyond Monday) since the international Brexit response back in June 2016. Both the Dow 30 and Nasdaq registered comparable historical declines. While most will be watching for nearby, long-term trendlines for these indices (at approximately 2,550; 23,700 and 6,385 respectively); I believe it is more important to monitor volume and open interest. Large moves backed by thin markets are often flashes that snuff themselves out. Velocity and volume on the other hand combine to make momentum.  

Volatility Products Under the Microscope: After the extreme charge in the VIX at the beginning of the week – the largest single day increase on a percentage basis since the index was introduced – there has been an intense evaluation done of the state of this derivative. Originally, this was intended as a measure or indicator to tell us how uncertain the future was so that we may be able to hedge appropriately. However, as with anything that becomes popular and has even a passing connection to traders’ much-coveted volatility – and this is volatility – securitization followed. VIX futures led to VIX options which then led to VIX ETNs. The popularity of these products has proven quite remarkable over the past years, but so too did the flaws become apparent in trying to work leveraged and inverse products out of this simple measure of activity. With the implosion of popular ETNs like XIV, the question becomes how much capital is tied up into these assets and how much correlation is there to other assets and portfolios? This is not likely to be another ‘subprime housing’ situation, but it can prove quite large and disruptive.

Bank of England Threatens Hikes: The latest policy announcement from the Bank of England produced a dramatic hawkish shift in official rhetoric. Recent underperformance in UK economic data outcomes and expectations for slowing growth and inflation in 2018 were brushed aside. Governor Mark Carney signaled that tightening might need to happen sooner and to a greater degree than previously expected. Perhaps most significantly, this marks an important ideological pivot for the rate-setting MPC committee, pushing into the background its previously long-standing concerns about Brexit-related headwinds. The British Pound duly soared against its major counterparts.

US CPI and Fed Forecasts: The recent bout of market turmoil has set off following the release of January’s US employment statistics, which showed that wage inflation surged to an 8-year high of 2.9 percent. That stoked fears of an unexpectedly aggressive tightening cycle, punishing asset prices buoyed by nearly a decade of ultra-loose monetary policy. The week ahead brings official US CPI data, which is expected to show the headline and core inflation rates ticked down last month. If the realized outcomes echo the jump in wage costs and produce an upside surprise, another bout of violent selling across global stock exchanges coupled with further gains in the US Dollar may be in offing.

ASX200: Worries about a steeper Fed rate hike cycle triggered by January’s unexpectedly dramatic surge in wage inflation have translated into market-wide risk aversion, sinking shares across the world. Nearly 80 percent of global monetary transactions involve the US Dollar, so when the Fed pushes up the cost of borrowing in the benchmark currency, it makes credit broadly more expensive on a worldwide scale. Australian shares have suffered alongside counterparts across the equity space, shedding over 5 percent in a mere two days before a slight recovery. The top-two sectors – financials and materials – have shed over 2 percent since the beginning of the month. Utilities have suffered the largest losses however.

Commodities:  Gold is on the defensive as an increasing focus on Fed rate hike prospects translates into a resurgent US Dollar, undermining the appeal of non-interest-bearing and anti-fiat assets epitomized by the yellow metal. Sentiment-sensitive crude oil has turned lower in tandem, with pressure from Fed-inspired risk aversion compounded by the de-facto downward pull of a stronger greenback. Iron ore has traded higher however. Chinese imports surged to 100 million metric tons in January, the second-highest monthly inflow on record, amid speculation that steel demand will rise when winter output restrictions are lifted.  

Australian Dollar: The Aussie Dollar is closing out another general decline against its most liquid majors and the technical pressure is getting more significant heading into this final day of trading for the week. It has been difficult to miss the A$’s pain whether we measure against the strong Chinese Yuan, the flippant Japanese Yen or the course shifting US Dollar. Looking to an equally-weighted index of the 7 most liquid Aussie Dollar crosses, the currency has dropped 7 of the past 8 trading days and has covered a range dating back over a year. For many pairs, further losses will translate into a technical break with far greater pressure for follow through and the same is true for the index. Normally, the RBA Monetary Policy Statement due today would be low priority, but in this state, traders will be on high alert for any trouble – and fading rate forecasts are a deep well for that.

Market Update:

SPI futures moved 13.89 or 0.24% to 5890.7.

AUD/USD moved -0.0023 to 0.78.

On Wallstreet: Dow Jones -2.29%, S&P 500 -1.35%, Nasdaq -2.14%.

In New York: BHP -1.77%, Rio -2.06%.

In Europe: Stoxx 50 -2.24%, FTSE 100 -1.49%, CAC 40 -1.98%, DAX 30 -2.62%.

Spot Gold moved 0.08% to US$1319.47 an ounce.

Brent Crude moved -1.24% to US$64.7 a barrel.

US Crude Oil moved -1.2% to US$61.05 a barrel.

Iron Ore moved 1.81% to CNY533.5 a tonne.

LME Aluminum moved -0.55% to US$2158 a tonne.

LME Copper moved -2.77% to US$6880 a tonne.

10-Year Bond Yield: US 2.84%, Germany 0.76%, Australia 2.89%.


Written by: John Kicklighter, Chief Strategist, DailyFX


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